Brief
ing
Sheet
s for
Buyer
Objectives
s
INVENTORY
CONTROL
When you have studied this briefing sheet you should be able to:
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Identify the decisions to be taken with regard to inventory
Explain why organisations hold stock
Identify the costs associated with stock
Explain the relationship between stock costs and order quantity
Calculate EOQ
Explain the limitations of EOQ
Explain the difference between dependent and independent demand
Describe the replenishment techniques of
 Periodic review
 Reorder point
Explain how redundant/obsolete stock can be minimised
Explain the concept of service level
Describe the documents used to record stock transactions
Describe the necessary features of a stock coding system
Explain the role of purchasing in managing inventory
© 2003 Meadowgate Training Ltd
Inventory Control Decisions
There are essentially two decisions to be made about each item held in inventory:
 How much to order
 When to order
The answer to “How much to order” is usually:
 Top up to a pre-determined level, or
 Economic order quantity (EOQ), which is explained later in the briefing sheet.
Two common techniques for determining when to order are:
 Periodic review (Fixed interval, variable quantity)
 Re-order point (Fixed quantity, variable interval)
Reasons for Holding Stock
In an ideal world, organisations would not have stock, goods would be delivered when needed. In
practice, stock is held and the reasons for this fall into two categories:
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Safety stock, eg:
 To protect against unpredicted demand
 To protect against disruptions in production
 To protect against other supply problems
 To smooth production
A consequence of lot-sizing decisions, eg:
 Bulk buying to reduce cost
 Advance buying in anticipation of price increase
© 2003 Meadowgate Training Ltd
Stock Costs
Buyers need to take account of four costs when making purchasing decisions.
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Costs of acquiring stock, eg:
 Information system
 Preparing requisition
 Vendor selection
 Processing purchase order
 Processing goods received note
 Processing payment
 Set-up
Organisations which calculate these costs typically quote amounts between £50 and £100
per order placed.
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Costs of items purchased, including the effect of quantity discounts
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Costs of not holding stock, such as the Opportunity Cost of lost sales/goodwill
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Costs of holding stock
 Opportunity cost of working capital
 Space
 Insurance
 Stock loss
 Warehouse staff
The annual cost of holding stock can easily be as high as 25% of the stock value.
© 2003 Meadowgate Training Ltd
Impact of Stock Costs
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Many small orders increase ordering costs
Few large orders increase stockholding costs
Total costs
£
Holding costs
Acquisition costs
Order quantity
Economic Order (Batch) Quantity
The ideal quantity to order is the one where total costs are minimised, which is where:
Holding costs = Ordering costs
This quantity can be calculated using the following formula:
EOQ =
2Co D
CH
Where
CO = cost of placing an order
D = annual demand
CH = cost of holding one unit in stock for a year
© 2003 Meadowgate Training Ltd
Limitations of EOQ
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Assumes that demand is constant over time
Assumes stable prices
Difficult to Determine CH and, especially, CO
Ignores space limitations, shelf life
Ignores capacity
Ignores cash flow
Despite this, it is widely used and it provides a useful check on other methods of deciding the
quantity to be ordered
Dependent/Independent Demand
The techniques used to decide when to order goods vary with the nature of the demand for these
goods. Demand may be:
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Dependent (demand for component depends on demand for parent assembly), or
Independent (not dependent eg. Retail/Warehouse/Finished Goods)
Replenishment Techniques for Independent Demand Items
Replenishment of inventory of goods subject to independent demand can be managed by one of
two techniques:
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Periodic review
Re-order point
Periodic Review
This method uses the following procedure:
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Review the stock level of an item at regular intervals and order to replenish stock to a predetermined level
Use Pareto analysis (see separate briefing sheet) to help set length of review periods
Review by physical inspection or stock records
The order quantity depends on the predicted consumption until the next review
Use safety stock in case of unusually high demand
© 2003 Meadowgate Training Ltd
Fixed order quantity (Re-order point)
This method uses the following procedure:
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Order when stock falls to a pre-determined level
The pre-determined level depends on demand during leadtime
Use safety stock in case of unusually high demand
The method assumes stable stock usage and stable leadtimes
Stock levels can be measured using:
 Stock records, or
 A “two bin” system
 Order quantity is often determined by Economic Order Quantity
Redundant/obsolete/damaged stock
Stock is Redundant if it is excess to foreseeable requirements. It is Obsolete if it is outdated
(includes items beyond the shelf life)
Regular checks should be made to identify this stock and either make it usable or dispose of it. It is
better, however to avoid its existence in the first place.
Redundant/obsolete stock can be avoided by:
 Monitoring demand patterns & adjust stockholding policy
 Effective communication with marketing, design
 Low stockholding on high risk items
 Matching timing of supply to consumption
 Stock record accuracy
Damaged stock can be avoided by:
 Checks on receipt of goods
 Appropriate packaging
 Stock rotation
 Environmental controls
 Appropriate handling equipment
 Staff training
© 2003 Meadowgate Training Ltd
Service Level
The objective of inventory management in many organisations is to balance investment in
inventory against “service level”
Service level measures the extent to which demand has been met from stock
=
Demand satisfied x 100
Total demand
eg.
200 items ordered last week
150 available
150
 100  75 %
Service level =
200
Stock records
Effective inventory management depends on reliable stock records. These may be manual or
computer-based. The minimum information required for each item in stock is:
 Quantity on hand
 Location
although stock records often contain additional information which may be useful to stock
controllers and buyers. The uses of stock records include:
 Providing a basis for the stock count (for valuation purposes)
 Identifying when to reorder
 Costing
The accuracy of stock records is dependent on reliable systems for recording the receipt of goods.
Typical documents used for this include:
 An internal record (for accounts, purchasing, etc.) – “Goods Inwards Note”
 Details from the supplier – “Advice Note” “Packing Note” & Internal transfer documents
 Details from the carrier – “Consignment Note”
Proper control of issues from stock is also essential. This includes:
 Authorisation to issue stock
 Record of issue/receipt for goods issued
The recording of stock issues may be by means of a stores requisition, pick list, or other appropriate
document. This is likely to contain the following information:
 Serial number
 Cost code/job number
 Part number
 Quantity
 Authorisation signature
 Signature of recipient
 Signature/identity of stockkeeper
© 2003 Meadowgate Training Ltd
Part Numbers (codes)
Stock record errors can arise where part numbering is not properly controlled.
A good coding system will provide unique part numbers which are:
 Unique
 Short
and the system will be:
 Expandable
 Centrally controlled
Codes may be sequential or significant (where information about the part can be deduced from the
part number). Significant coding results in longer numbers.
Role of purchasing
The role of a buyer in relation to inventory management may include:
 Deciding on ordering policy (including use of tools like EOQ)
 Balancing conflicting objectives (eg. Customer service, inventory)
 Taking account of
 Demand patterns
 Space
 Material availability
 Supplier capabilities
 Cashflow
© 2003 Meadowgate Training Ltd